Asian asset owners get pickier with private credit
High interest rates and market volatility have made asset owners in Asia more selective in private credit, pushing fund managers to adapt their investment approaches and fundraising pitches.
Amid high cash returns and higher default risks, investors now seek strategies with visibility, lender-friendly terms, and stronger downside protection, according to fund managers, who are also facing tougher competition.
Private credit has been popular among investors because it is not subject to mark-to-market volatility, said a senior director of a Hong Kong-based family office.
He noted the importance of not grouping private credit as one category since opportunity sets can vary among different managers, although funds usually flow to the biggest managers.
While the current environment makes private credit investments interesting, the family office director was not actively deploying capital, partly due to growth uncertainties and high cash returns.
TOUGH COMPETITION
Similarly, Singapore-based family office JRT Partners told AsianInvestor recently that it was sitting comfortably with cash, which has been generating a 3-5% return. There is no rush for the family office to get into new opportunities, chief investment officer Tuck Meng Yee said.
The competition with cash is one of the challenges for private credit fund managers’ fundraising in the current cycle, especially for the mainstream middle market direct lending space, which traditionally provides high single-digit returns, up to around 10%.
Marc Preiser, Fidelity International’s portfolio manager for European direct lending, noted that there are still illiquid premiums in the private credit space, but the question remains as to whether that is enough to tempt investors away from cash.
“That's something that's challenging us in the direct lending world,” Preiser told AsianInvestor.
Under the circumstances, he said the advantages of private credit investments are the private market diversification, a long-term perspective that locks in higher rates, and the consistent stable income generation with relatively low volatility.
The global private credit market is a rapidly growing segment: It is now estimated at $1.5 trillion, up from about $440 billion a decade ago, according to Preqin.
One way to differentiate private credit strategies is by the EBITDA of borrowers. More than half of the market is middle market direct lending, a highly competitive space where loans mostly go to private equity-sponsored companies.
The core of that market usually consists of smaller borrowers below $30 million of EBITDA, while the larger direct lending market focuses on companies above $75 million EBITDA. That market can sometimes compete with syndicated loans, Preiser noted.
PRESERVING CAPITAL
Barry Chung, Fidelity’s director of private asset sales for Asia ex-Japan, said within Asian investors’ alternative allocation, about half typically goes into private equity, while a quarter can go towards private debt.
The volatility in the real estate sector in Asia prompted investors to tilt towards other sectors such as infrastructure, private equity, and private credit, Chung told AsianInvestor.
These included sovereign wealth funds, pension funds, and insurance companies from Japan, Korea, Hong Kong, China, Singapore, and Australia, which are the majority of Fidelity’s private credit asset owner clients.
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“They have experienced the denominator effect across asset classes. So, they are looking for ways to preserve their capital. They're not trying to find a better way to increase their overall return, which private equity tends to provide,” Chung said.
During his roadshows in Asia earlier this year, Chung said he was told by a North Asian asset owner that they saw the private credit market as a “red ocean”, meaning an established market with many competitors.
Chung agreed with the characterisation of fierce competition. Current conditions are akin to a battlefield where better documentation, negotiation, and transparency of portfolio companies are what is required to justify a strategy's risk-reward profile.
“All of these things really matter to our due diligence process, especially in a cycle like today,” Chung said, noting that investors are looking for fund managers with a decade-long performance history and proven resilience through diverse economic conditions.
DOWNSIDE PROTECTIONS
Echoing Chung’s comments, Baxter Wasson, co-head of UBS Asset Management’s opportunistic private credit unit, known as O'Connor Capital Solutions (OCS), said the focus on lender-friendly terms and structural protections are especially important to investors now.
“I think the market broadly has a little bit of a question mark in their minds about are we going into a recession, are we going to have a slowdown, and what is the impact of rising rates on interest coverage ratios and on refinancing,” Wasson told AsianInvestor.
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The interest coverage ratio is used to determine how easily a company can pay interest on its outstanding debt – the higher the better for investors.
OCS lends to small and mid-sized family- or founder-owned businesses and assets.
“With all of that on their mind, I do think that investors are looking for strategies where they can look at the strategy and say, yes, I understand how I've got good protections in that strategy and therefore I can think more concretely about the relative value. I'm not wearing a lot of volatility that could erode the theoretical returns.”